DBRS Morningstar Confirms Republic of France at AAA, Stable Trend

DBRS Ratings Limited (DBRS Morningstar) confirmed the Republic of France’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA. At the same time, DBRS Morningstar confirmed the Republic of France’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trends on all ratings are Stable.

KEY RATING CONSIDERATIONS

The ratings are underpinned by France’s wealthy and diversified economy, strong public institutions, and financing flexibility. The confirmation of the Stable trend reflects the government’s commitment to address the country’s structural challenges and support economic performance. Recent revisions to the government’s deficit targets do not reflect a retreat by authorities from their policy commitments. DBRS Morningstar expects the government to continue its push to implement ambitious structural reforms, although possibly at a slower pace than in recent years. The reform agenda is meant to improve France’s medium-term fiscal balance and reinforce its long-term debt metrics.

The country’s strengths are principally offset by structurally high public expenditures and high public-sector debt. Even if the government is successful at reducing public expenditures in line with its current 2022 targets, public spending in France will still account for over half of nominal GDP and remain well above the EU average for public expenditures. Further still, the trajectory of France’s public debt ratio has yet to peak and is expected to reach 98.8% of GDP in 2019. Even as the implicit cost of debt declines, the high debt burden reduces the country’s ability to respond to future shocks.

RATING DRIVERS

Downward ratings pressure could emerge if adverse developments cause authorities to reverse on their fiscal and debt commitments, including: (1) the expected reduction in public expenditures as a share of GDP, (2) improvement in the structural fiscal balance, or (3) the planned decrease of the country’s high debt-to-GDP ratio.

RATING RATIONALE

Social Tensions have Eased Since the Beginning of the Year

Social tensions, principally expressed by the weekly yellow vests’ protests, have tempered since the initial outbursts in November 2018. This is primarily due to the government’s effective broad-based policy response. Since the end of 2018, the government has delivered large fiscal easing measures, adopted a more conciliatory political stance, and conducted a two-month nationwide public consultation. DBRS Morningstar points to the rebound in the government’s approval ratings since the end of last year as evidence of effective public engagement. Even after this government’s passage of important structural reforms since taking office in 2017 – to tax policy, and labour and product markets – it is key for the government to maintain public support in order to follow through on its remaining reform priorities.

Difficult reforms are still pending and the legislative road ahead for the government is complex. Difficult discussions are underway to reform the pension system, where there are many impediments to change. Furthermore, the ambitious plans to transform the public administration and reduce the large number of civil servants by initial targets have now been abandoned. The President conceded that reducing the civil service in the central government by the initially targeted 50,000 positions by 2022 will not occur. Only 5,290 jobs are expected to be eliminated from 2018 to 2020. Despite the government’s parliamentary majority, current social and political realities pose persistent reform challenges.

New Spending Commitments Cause Fiscal Slippage, But Debt Servicing Remains Affordable

The deficit is expected to temporarily breach the 3% of GDP threshold in 2019 for two reasons. First, the deficit increases this year due to a one-off replacement of the tax credit (CICE) with a permanent reduction in employer social security contribution, corresponding to 0.9% of GDP. Second, the deficit widens beyond previous expectations as a result of slower economic growth and additional fiscal easing adopted to quell public protests. Tax cuts, primarily targeted towards lower-income households, are expected to equal just under €20 billion in 2019-20. The 2020 Budget forecasts a 2.2% deficit next year, declining to 1.5% by 2022. DBRS Morningstar considers consolidation of the fiscal balance critical for France to fortify its fiscal anchor and place debt on a more accelerated downward trajectory.

France’s debt ratio remains among the highest in its AAA-rated peer group. According to the 2020 Budget, public debt to GDP is expected to peak in 2019 at 98.8% and decline only gradually until 2022. Absent a more aggressive fiscal consolidation, France will likely maintain its high debt burden for the foreseeable future, reducing its ability to respond to future shocks. Nonetheless, accommodative monetary policy and France’s prudent debt management strategy helps mitigate risk. France’s position in Europe provides the Treasury with substantial funding flexibility that allows it to maintain a higher level of indebtedness at low costs. This supports DBRS Morningstar’s assessment of the Debt Management and Liquidity building block.

Amid an Increasingly Difficult External Background, Growth of the French Economy has been Resilient

Despite headwinds to growth, the French economy is a strong performer among the large European countries. Following average 2.1% growth in 2017-18, the 2020 Budget assumes growth of 1.4-1.3% in 2019-20. This growth performance would remain well above the expected growth rates for Germany (0.6-0.9%) and Italy (0.0-0.5%) over the same period, and roughly on par with measures of output potential and with average growth of the Eurozone.

Domestic demand is being weighed down by slower investment growth, while supported by expansionary fiscal policy and favourable developments in wage and employment growth. External demand has slowed due to the weaknesses among other large European countries, persistent threats of US-centred trade conflicts, and the ongoing Brexit delays. Nonetheless, France has no noticeable external imbalances. It is expected to record manageable 2019 deficits in the current account balance and the international investment position. The country’s open economy with extensive trade, investment and financial linkages throughout Europe and around the world support DBRS’s assessment of the Balance of Payments building block.

Risks to Financial Stability Appear Manageable

The banking sector appears well positioned to support economic growth. Bank balance sheets have strengthened, and credit conditions remain supportive of the economy. Low domestic interest rates and strong confidence indicators have helped spur credit growth. High private sector debt is still worth monitoring. Combined household and nonfinancial sector debt reached 132% of GDP in 2018, according to the Banque de France, up 45 percentage points of GDP since 2000. Net of intercompany lending, offsetting cash holdings, or other liquid assets, risks associated with private sector indebtedness appear more contained. A main challenge for the French financial system has been to operate in an environment of low interest rates. Bank margins have been squeezed by declining lending rates to households and corporates, in a context of regulated deposit rates.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments.
http://www.dbrs.com/research/352121

EURO AREA RISK CATEGORY: LOW

Notes:

All figures are in Euros unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS Morningstar website www.dbrs.com at http://www.dbrs.com/about/methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The sources of information used for this rating include Ministry of Economy and Finance, INSEE, Banque de France, Agence France Tresor, High Council on Public Finances, IMF, World Bank, UNDP, Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

This rating included participation by the rated entity or any related third party. DBRS Morningstar had no access to relevant internal documents for the rated entity or a related third party.

DBRS Morningstar does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU and US regulations only.

Lead Analyst: Jason Graffam, Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer – Global FIG and Sovereign Ratings
Initial Rating Date: May 12, 2011
Last Rating Date: April 26, 2019

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